VWAP (volume-weighted average price) definition

What is VWAP?

VWAP is the abbreviation for volume-weighted average price, which is a technical analysis tool that shows the ratio of an asset's price to its total trade volume. It provides traders and investors with a measure of the average price at which a stock is traded over a given period of time.

VWAP is commonly used as a benchmark by investors who want to be more passive in the market – usually pension funds and mutual funds – and traders who want to ascertain whether a stock was bought or sold at a good price.

To calculate VWAP, you use the following equation:

VWAP = ∑(amount of asset bought x asset price)/total shares bought that day

The standard VWAP is calculated using all of the orders of a given trading day, but it can also be used to look at multiple time frames.

The VWAP ratio is then presented on a chart as a line. It has been likened to a moving average, in that when the price is above the VWAP line the market is seen as in an uptrend, and when the price is below the VWAP the market is in a downtrend.

Pros and cons of VWAP

Pros of VWAP

VWAP ratios are used in algorithmic trading to help traders and investors to determine the best price at which to buy or sell, in line with the volume of the market. By ensuring high liquidity, traders can usually expect lower transaction costs and best execution.

VWAP is particularly useful when trading large numbers of shares. Attempting to buy a large volume of a single stock on the market could artificially increase its price — by using VWAP, traders can ensure that they aren't overinflating the trading volume for the asset they want to buy.

Cons of VWAP

There are a few issues associated with using the VWAP ratio. Most of the problems stem from the fact a VWAP is a culminative indicator, meaning it relies on a vast amount of data points that will only increase in quantity throughout the day. Having such a large data set can cause lags in the VWAP line, in a similar way to moving average lags, which is why most traders and investors only use one-minute and five-minute timeframes.